Fed’s Statement Signals Inflation Threshold Met

At the last meeting in 2021, the Federal Reserve decided to increase the pace of the QE tapering and the projections of the FOMC staff showed a potential of three rate hikes for next year.

Analysts at Wells Fargo, point out the bar for rate hikes now rests squarely on the labour market, with the statement indicating that the inflation threshold even under the Fed’s new flexible regime has been met.

With inflation expected to run further above target through next year and the labour market making steady progress toward full employment, the projected path of the fed funds rate moved higher relative to the September dot plot. Based on the median projection, participants have now penciled in three 25 bps increases over 2022 after having been evenly torn between zero and one hike in September.

The median projection among Committee members calls for 75 bps of tightening in 2023 followed by another 50 bps in 2024. If realized, that would put the fed funds target range at2.00-2.25% at the end of 2024, a touch below where the FOMC estimates policy would become restrictive.

Market pricing over the next two years is roughly in line with the median projection for six cumulative rate hikes through year-end 2023, but beyond that markets are priced for very little additional tightening. We are skeptical of this market pricing, and this is one reason we look for the 10-year Treasury yield to steadily move toward 2% as 2022 progresses.